What Is a Discretionary Trust?

A discretionary trust is one of several types of trusts that you might consider when writing your last will and testament. By leaving your estate to a trust in your will, you can give the responsibility to your trustees to decide how your assets are distributed to beneficiaries.

This can be advantageous in some circumstances - for example, discretionary trusts can help to manage assets on behalf of beneficiaries who do not have the capacity to do so on their own, or enable you to choose people who have not been born yet as beneficiaries.

However, you should consider the tax implications and the other types of trusts that may suit your purposes, and ensure you fully understand how a discretionary trust works before setting down your intentions in your will.

To help make sense of this estate planning option, Clough & Willis' probate team has written this blog to answer some fundamental questions:

• what is a discretionary trust?
• how much control do trustees have over your assets?
• how do you know if a discretionary trust is right for you?

If you need more advice, call our team on 0800 083 0815 or use our online enquiry form to get in touch.

How do discretionary trusts work?

By leaving your estate, or part of your estate, to the care of a discretionary trust, you allow your nominated trustees to manage how this is distributed after you die. The underlying principle of this particular trust is that your Trustees have absolute discretion in how, when and to whom assets are distributed- but only to beneficiaries that you specify beforehand.

You can name specific beneficiaries, general classes of people (such as “grandchildren”), or even organisations/charities. This includes people that have not even been born at the time of preparing the Trust.

When you die, your Trustees have the right to distribute your estate in any way that they see fit, having consideration to any prior instructions that you leave behind. It is therefore imperative that you appoint people in this capacity that have an awareness of the circumstances surrounding the Trust creation, and more importantly, people that are going to honour your wishes.

On paper, a discretionary trust confirms that your trustees are to hold the trust fund for the benefit of potential beneficiaries – you can name as many beneficiaries as you would like; however, it is important to note that those named may benefit in any way that your Trustees think fit. For instance, you may name your spouse and broader relations, such as nieces and nephews. The question to consider is whether you would want your nieces and nephews to benefit the same as your spouse.

It is therefore important that you provide your Trustees with detailed instructions on how you wish the trust to be distributed (insofar as you are able to do so). For instance,  you may request that your trustees consider your spouse as the primary beneficiary and following their death, the other named beneficiaries are to be treated equally. The Trustees do not have to comply with your wishes, which is why it is important to consider all circumstances when appointing people in this position.

A discretionary trust is a complex legal instrument, and it is extremely important that it is drafted correctly. Poor drafting and lack of detail can lead to complexities in the administration of your estate which can otherwise be avoided; it is therefore advisable to seek the assistance of an expert solicitor. If you feel that this approach is right for your estate, speak to an experienced wills and trusts lawyer for advice and guidance.

What are the most important considerations when establishing a trust?

If you wish to establish a discretionary will trust, you will need to take care when choosing your trustees. The trustees will ultimately decide how your assets are distributed to your beneficiaries, so you need to ensure that they understand why the trust is being created and more importantly, that they can be trusted to execute your wishes faithfully.

You must also make sure that there are no conflicts of interest that would prevent trustees from executing their duties. There is no law to prevent your trustees from being named beneficiaries of the will, but you may wish to include some trustees who do not stand to financially benefit from the trust as a way to address these conflicts of interest. You may wish to nominate a solicitor or other professional to fulfil this function.

You should also check that a discretionary will trust is the right type for your purposes. As we will explain below, there are several different types of trust, and it is important to consider your ultimate objectives carefully before deciding how you will structure your will in order to achieve them.

Finally, remember to review your will and trust arrangements periodically, especially when significant life events or changes in circumstances occur. In this way, you can periodically verify that your will continues to meet your needs and intentions.

How do discretionary trusts affect Inheritance Tax liability?

If your estate exceeds the current Inheritance Tax (IHT) threshold of £325,000, the tax paid on anything above this is charged at 40%. For larger estates, this can have a significant financial impact. The executor of your will must calculate your tax position, estimate the estate’s value, and pay any outstanding IHT - often by selling or realising assets.

Placing assets into a discretionary trust fund can help manage this liability, as it changes how your estate is valued. Instead of being taxed as part of the estate at the full Inheritance Tax rate, trust income is subject to different tax rules. Any rental income or other earnings generated within the trust fund may be taxed separately, depending on the type of income - whether it falls under non-savings income or investment earnings.

Assets taken from the trust are taxed at lower rates than the standard IHT rate, and some trusts qualify for a tax credit to offset the tax paid. If a property is placed in a trust rather than directly inherited, it may also affect how Capital Gains Tax is applied if the property is later sold. There are also potential tax advantages for those passing down their only or main residence, depending on how the trust is structured.

Given the complexities of Income Tax liability, Capital Gains and the tax treatment of trust income, it is always advisable to seek professional advice. A solicitor or financial adviser can help you understand how much income may be subject to tax, explore relief options and make sure your assets are passed on in the most tax-efficient way.

What are the advantages of using a discretionary trust?

Beyond the tax-relief advantages of discretionary trusts, there are other reasons that they are among the most common estate planning strategies. For example, this type of trust is particularly useful when beneficiaries may not be able to manage their inheritance due to factors such as financial inexperience, a lack of mental capacity or problems with addiction.

For example, it may be appropriate to provide your beneficiary with a periodic income to support their general wellbeing; something that cannot otherwise be done without a discretionary trust.

A further example would be a situation where your designated beneficiary does not currently have the ability to manage their finances; whether that be a temporary mental incapacity, addiction or otherwise. In such a circumstance it would be unwise to leave them a lump sum in your Will as it is not foreseeable when you will die or when the beneficiaries’ circumstances will change. A discretionary trust will allow your trustee to distribute their entitlement at a time of their choosing and subject to a change in the beneficiaries circumstances.

Discretionary trusts provide flexibility for changing circumstances such as this and more broadly assist in protecting assets against creditors or divorce claims.

What are the disadvantages of a discretionary will trust?

The disadvantages to a discretionary trust include the fact that you will lose control over your assets and not be able to make specific decisions about how your loved ones should benefit after you die. Discretionary Trusts can be in place for a very long time and whilst Trustees are charged with protecting the Trust Fund, they are faced with obvious risks such as market fluctuation and inflation amongst other things.

For this reason, it is vital to speak to an expert probate solicitor when you want to establish a discretionary trust, or if you want to explore other options that might be appropriate for estate planning.

Are there other types of trusts?

Along with discretionary trusts, there are several other types of trust that you can include in your will. It is best to speak to a solicitor about estate or tax planning services if you are concerned about the Inheritance Tax liability your estate will incur. By approaching this process with these considerations in mind from the outset, you will be able to structure your estate and your gifts in the most tax-efficient way possible. The most common types of trusts that you can create in your will include:

Bare trusts

A bare trust is the simplest type of trust. It is often used when the beneficiary is under 18 years of age and, as a result, unable to hold assets in their own name. A bare trust enables a trustee to hold the assets, but this person will have no discretion over the distribution of assets. Once the beneficiary reaches the age of 18, they are entitled to receive the assets in their entirety.

Interest in possession trusts

In this type of trust, a beneficiary (who is referred to as the life tenant) has an immediate and automatic entitlement to any income generated by the trust assets. The life tenant does not have access to the underlying capital, which is preserved for the remainder beneficiaries. Upon the death of the life tenant, the capital assets are distributed to the remainder beneficiaries as specified in the will.

Protective trusts

A protective trust is designed to provide financial security for a beneficiary, while also safeguarding the trust assets from any potential financial risks. This arrangement grants a life interest to the primary beneficiary and the trust assets pass to the remainder of the beneficiaries. If the primary beneficiary becomes bankrupt or tries to assign their life interest to creditors, the life interest comes to an end. This means that the trust assets are protected and preserved for the remainder beneficiaries.

Charitable trusts

A charitable trust is established to benefit a specific charitable purpose or organisation. The assets within the trust are used to support the chosen charitable cause, and any income generated by the trust assets is generally exempt from tax.

These are not the only types of trusts, but they are among the most common. Placing your assets in a trust such as those listed above can help to provide financial security for beneficiaries, safeguard assets from financial risks, and support charitable causes, meaning that it is often worthwhile for a variety of estates.

When considering your will and choosing which type of trust will best suit your requirements, it is essential to consider the objectives you wish to achieve, and the specific needs and circumstances of your beneficiaries. Consult a solicitor who specialises in wills and trusts for support in choosing the right trust to meet your needs, and advice on how you can structure your estate in a way that minimises your tax liability.

To speak to the probate experts at Clough & Willis Solicitors, call us on 0161 764 5266 or complete the quick enquiry form on this page to request a call back.